Netflix (NFLX -0.20%) is the world’s largest streaming company, and while it pioneered the industry, it now faces an avalanche of headwinds. For example, it’s becoming harder for the platform to grow because of its enormous size, and it’s also facing competition from over 80 other providers.
But Netflix is leaving no stone unturned when it comes to finding new paying customers. It has released a cheaper subscription tier supported by advertising, and it’s also cracking down on password sharing.
Those initiatives appeared to drive some serious momentum across Netflix’s business in the third quarter of 2023 (ended Sept. 30), and investors loved what they saw. They sent its stock surging 14% higher following the release of the Q3 report, but since it remains 42% below its best-ever level, I’ll explain why there could be even more upside around the corner.
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Netflix is in the middle of a transition to unlock more growth
Netflix started out in 1997 by mailing physical DVD movies to customers, and its founders were famously laughed out of the room when they wanted to sell the company to video rental chain Blockbuster a few years later. But the transition to streaming in 2007 changed everything; Netflix is now one of the biggest names in entertainment globally, and Blockbuster is bankrupt.
Netflix has 247.1 million subscribers, which is about 100 million more than what is widely considered the No. 2 streaming service, Disney+. But as I touched on earlier, it has been tough for Netflix to generate growth lately because its customer base is already so large. As a result, the company is now pursuing two primary strategies.
First, it’s expanding its addressable market to capture a wider audience. The platform’s premium subscription is priced at $22.99 per month, but it introduced a $6.99-per-month tier in 2021 that is supplemented by advertising to appeal to consumers at a lower price point.
Second, Netflix is trying to monetize users who already love the service, but are borrowing it for free from a friend or family member. Management estimates there are around 100 million of these potential customers around the world, and it has started to block their ability to use Netflix without paying. The platform introduced a new $7.99 “sharing” option, which allows a primary account holder to add other users outside their household at a lower cost than purchasing a regular subscription.
Both of these strategies appear to be working, because in Q3, Netflix added 8.8 million new paying subscribers, which was the best result since mid-2020 — at the height of the pandemic. Managementsaid ad-tier subscriptions jumped 70% in just the last three months, and they accounted for almost one-third of new sign-ups in countries where it’s available. Similarly, retention has been strong amid the crackdown on password sharing with fewer people canceling their subscriptions than expected.
More subscribers equals more revenue and more profit
I was among those people concerned that any new subscribers acquired through the advertising tier and the paid sharing tier wouldn’t lead to much faster revenue growth for Netflix, because of the lower price points. But its Q3 results proved me wrong, because revenue came in at $8.5 billion, which was up 7.8% year over year.
While that is still relatively modest at face value, it was the fastest growth rate in four quarters, which proves Netflix is still capable of delivering an acceleration going forward. The advertising tier has been a particularly impressive contributor, because while it’s only priced at $6.99 per month, the company says it generates as much revenue per user as the Netflix Standard plan, which is priced at $15.49 per month. And as more users join the ad tier, it will attract more advertising dollars.
Netflix’s profitability also benefited from the strong subscriber additions in Q3. See, streaming is a highly scalable business, which means producing content costs the same amount of money whether the platform has 100 million subscribers or 247 million subscribers. Theoretically, the larger the subscriber base grows, the more profitable Netflix becomes organically.
The company delivered $3.73 in earnings per share (profit) in the quarter, which was an increase of 20% year over year. Earnings growth clearly far outperformed revenue growth, and that’s because Netflix spent less on content due to the writers’ strike that ground much of the entertainment industry to a halt.
Why Netflix stock is a buy now
As strong as Netflix’s third-quarter results were, the company expects even more growth going forward. It has forecasted a 10.8% revenue increase for the upcoming fourth quarter, which would mark an even further acceleration. It just instituted a price increase for its Basic and Premium plans in major markets like the U.S., France, and the U.K., which will boost its Q4 financial performance.
Netflix stock is slightly expensive by traditional metrics. The company is on track to generate $12.05 in earnings per share for 2023, which places its stock at a price-to-earnings (P/E) ratio of 33.3. That’s about 11% more expensive than the Nasdaq-100 technology index, for example.
However, paying a small premium for Netflix stock might not be such a bad idea given the company forecasts a further acceleration in top-line growth. Plus, it has barely scratched the surface of its opportunity in the advertising segment, which management values at a whopping $180 billion (excluding China and Russia).
Remarkably — despite Netflix’s current P/E valuation — its stock is still trading 42% below its all-time high, so there could be plenty of upside ahead if the company keeps up its current performance.
